Rural credit

Credit has been an important instrument in IFAD's lending programme, as it represented up to about 50% of total IFAD commitments in Pakistan over the period under review. Credit has been geared towards both enhancing overall agricultural productivity and as a means to improve the opportunities for the target groups. The larger share of credit component resources has been channelled through the Agricultural Development Bank of Pakistan (ADBP). In more recent projects, lending has also been organized through savings and credit schemes as part of the search for participatory models of development.

Effectiveness and viability of institutional credit delivery

The Agricultural Development Bank of Pakistan had been relatively successful in increasing the share of loans to small farmers, particularly during the 1980s when their share increased to 45% of disbursements in 1988/89 as against 11% in 1980/81. This result owes much to the development of a countrywide network of branches and Mobile Credit Officers (MCOs). Donors' assistance has been instrumental in building ADBP's institutional capacity.

ADBP's financial capacity improved during the same period but could not be sustained. Since the inception of the second generation of projects, ADBP's financial viability has been deteriorating. Earlier externally-financed projects (including those financed by IFAD) had been supported by subsidized credit. Such interventions failed to recognize the negative implications of providing subsidised credit in terms of: unequal access to the credit; low recoveries; erosion of the value of banks' assets due to negative real interest rates; and administrative inefficiencies leading to higher lending costs.

Political interference in ADBP's policy-making and managerial matters is frequently indicated as being the main cause for low recovery rates, unsound lending, and bank over-staffing. The Bank suffers from a lack of stability in long-term policy-making and strategic management. Savings, often pointed out by donors as being the conditio sine qua non for long-term sustainability, is not an objective purposefully pursued by ADBP's management, under the prevailing conditions.

In this context, ADBP has also become somewhat reluctant to lend to resource-poor rural people who constitute an important segment of IFAD's target group: by 1992/93, the share of smallholders had declined to 21%. Its capacity to reach IFAD's target group is not likely to improve with the bank's present administrative and managerial set-up. The costs of borrowing are extremely variable and do not appear to be restricted to official expenses (e.g. to obtain the Pass Book, which is practically a prerequisite for borrowing). Lengthy procedures discourage borrowing for short-term production loans. Use of groups and NGOs for credit delivery has not been actively pursued so far.

Recently approved projects have adopted a participatory model which presents an interesting alternative to ADBP as a delivery mechanism. The project's design included a savings-mobilization component necessary for the cohesion of the group, but failed so far to use these savings as a source of credit. Further analysis should be done on the role of credit in this participatory model.

Credit targeting mechanisms: design and feasibility

To ensure that the project's credit resources are channelled to the target group, project design attempted the following:

(i) development of a village and client-centered approach through the expansion of the Supervised Credit Scheme (SCS), by bringing the credit services to the farmgate through MCOs;

(ii) relaxation of lending conditions, currently based on land mortgage, which excludes tenants, landless and women from access to most credit lines;

(iii) use of a loan ceiling, to discourage wealthy borrowers from competing for or hijacking the project's resources which are targeted at the poor; and

(iv) selection of specific population groups through eligibility criteria. In nearly all projects targeting disadvantaged groups of the population, the size of operational holding is used as the main eligibility criterion.

While the SCSs have accounted for much of the progress made in increasing target group's access to institutional credit, the other targeting instruments have had mixed results because of a number of practical difficulties. Firstly, the relaxation of lending conditions was not made and land mortgage continued to be a requisite security for borrowing. Secondly, baseline surveys on which effective targeting is generally dependant were often planned late and seldom completed in time to be useful during implementation. Thirdly, household incomes are very difficult to evaluate and project staff are unlikely to have either the time or the expertise for such an exercise. The land holding size criterion, while easier to handle, is also quite an imperfect measure of poverty as:

(i) it assumes that tenants and landowners display a similar behaviour with respect to risk aversion strategies, family labour, investment and credit;

(ii) it fails to identify and incorporate non-farm income, and for some groups (the landless in particular, as well as women) non-farm activities generate a large share of the household income; and

(iii) it does not consider further determinants of household poverty, such as social factors including location (area targeting), access to land, roads, health facilities, etc.

 Targeting versus financial viability: is there a trade-off?

Whether or not SCSs, particularly those targeted at the poor, impinge on the credit institution's financial performance is debatable. A case in point is represented by the question of lending to rural women: ADBP considers that increased lending to rural women is hampered by high operating costs of female Mobile Credit Officers (MCOFs). In fact,the relatively high cost of MCOFs programmes is basically due to the small size of their loan portfolios. Considering, in addition, the high recovery rate on loans extended to women for small-scale enterprises and their potential social and economic benefits, it could as well be argued that these programmes deserve to be given a fair opportunity to perform.

Lending to the poor may not be as expensive as it would appear from a partial analysis of the available evidence. Official records show that the overall incidence of SCSs on ADBP's administrative costs is marginal when compared to the losses corresponding to over-staffing and bad loans, for example. Supervised credit schemes do not operate only to serve the target groups. In fact, since the volume of lending operations had been the key criterion used to measure the performance of staff, priority has been given to extending large loans to large farmers thereby neglecting IFAD's target group. This practice also proved to be disadvantageous to ADBP, since recovery rates for large borrowers were, and still are, generally low.

The issue of viability leads also to the issue of interest rates, an essential element of the credit policy. GOP and donors have generally agreed that the interest spread has to cover administrative and other related costs of special credit programmes; for this purpose they have successively applied the following three complementary options:

(i) a reduction of the resource cost to ADBP;

(ii) the search for economies of scale in the transaction costs through the group-based credit delivery and mobile banking; and

(iii) an improvement of the administrative efficiency of ADBP.

Despite the application of the above three options, ADBP's performance remained below expectation.

As a fair conclusion, there may or may not be a trade-off between targeting concerns and those related to the sustainability of credit institutions, depending on the interaction of a complex set of factors including: direct transaction costs; risks; volume of operations; economic benefits generated; and managerial and policy aspects, including the structure of interest rates.

Recommendations

Donors and GOP do have some leverage on many of the above factors. They may either focus on one objective, currently ADBP's financial viability as a credit institution, or formulate appropriate credit policies that optimize a range of objectives. The evaluation believes it is the role of IFAD to proactively participate in this policy dialogue between donors and GOP to ensure that equity concerns are given adequate attention in the process. This approach is truly a developmental one, as it takes into consideration long-term development concerns when addressing short- and medium-term institutional issues.

Enhanced policy dialogue

IFAD has apparently paid little attention to the fact that it could be mutually advantageous for the credit institution and the target group to raise the nominal interest rate on small loans above the average lending rate of the bank. Not only would this measure provide a strong incentive to the bank to lend to the poor, but it would also be in the direct interest of the target group since:

(i) easy access to credit and suitable loan repayment procedures are much more important for the target group than cheap credit, given the much higher rates charged by informal money lenders; and

(ii) a subsidized interest rate is a major cause of diversion of the credit, initially earmarked for the target group, to better off households.

Admittedly, it is politically difficult for the Government to increase interest rates. Should the GOP agree in principle on the desirability of such a move, however, policy shift would obviously have to be implemented in a very progressive manner.

Political decisions at times forced ADBP to distribute unappraised emergency loans, or to reschedule the debts of borrowers in a disaster area. However necessary these decisions may have been, they heavily damaged loan recoveries and contributed to the widespread perception that public money lent by ADBP does not necessarily have to be repaid. GOP should bear the cost of such programmes directly from the public budget in the most obvious way possible.

In the light of experience, it is both desirable and feasible to introduce some competition among potentially interested credit institutions for the channelling of credit resources financed under IFAD loans. To this effect, GOP and IFAD should be prepared to accept higher interest rates for credit schemes targeted at the rural poor provided the concerned credit institutions:

(i) simplify lending procedures and relax collateral requirements;

(ii) strengthen their capacity to deal with special lending; and

(iii) agree to develop, with project support, specific financial packages in terms of their purpose and lending conditions, that serve most the interests and conditions of the target groups.

Community participation in credit dissemination could become a very effective targeting mechanism. IFAD should assist in the development of this model in the light of the experience gained under AKRSP.

83. The Fund should provide more resources in its future credit operations to livestock and Rural Non-Farm Activities (RNFAs), including cottage industries,The Fund should provide more resources in its future credit operations to livestock and Rural Non-Farm Activities (RNFAs), including cottage industries,The Fund should provide more resources in its future credit operations to livestock and Rural Non-Farm Activities (RNFAs), including cottage industries, for IFAD to significantly reach the landless and women.

On future cooperation with ADBP

MCOs need training and refresher courses on lending and recovery procedures, as well as monitoring loans to borrowers.

As far as SCSs are concerned, it is recommended that both IFAD and ADBP assess the possibility of separating MCOs (MCOFs in particular) working on SCSs from the current functional structure of the bank, both in terms of hierarchical relations and targets. The proposal is briefly outlined as follows:

(i) create a separate body of MCOs working exclusively on SCSs and provide such a department with autonomy to pursue the objectives of the pilot credit schemes on special lending;

(ii) fix their targets and reward mechanisms according to, firstly, the number of loans disbursed (instead of the amount disbursed); and secondly, the quality of lending, implemented by real appraisal of loan applications and measured by recovery rates;

(iii) make them functionally independent from the Regional Managers, whose reward mechanisms are currently in conflict with the objectives of the special schemes. Instead, link them directly to the Special Scheme Department in the head offices;

(iv) restructure the Department in such a way that it is managed by a few dynamic and highly motivated staff with a clear knowledge of special schemes and their problems in the field. No additional recruitment would be required except for MCOFs in the medium- and long-term;

(v) within the Department appoint one or more (few) MCO Supervisors with the task of visiting the MCOFs, assisting them in loan appraisal or with any other problem they might be facing, and sanction their loans; and

(vi) issue a rule that binds Branch Managers to disburse these loans quickly once sanctioned by the Supervisor.

Credit handling in community development projects

The following broad guidelines are recommended whenever a credit activity is to be integrated into the "savings component" of community development type projects:

(i) current savings deposited with a commercial bank could be used as group collateral;

(ii) an NGO, such as the Aga Khan Rural Support Project (AKRSP) (Loan No. 209) or Sarhad Rural Support Corporation (SRSC) (Loan No. 319), would supervise both the credit and technical aspects of the operation. Experience in Bangladesh clearly indicates that groups need intensive training before they become eligible for credit. The current practice in AKRSP areas where loan sizes are linked to the amount of the individual savings and increased level of credit-worthiness over time should be adopted;

(iii) all Social Organizers (SOs) should be able to assist their Village Organizations (VO) members on credit issues, including religious issues related to the banking system in Pakistan;

(iv) projects are advised to engage only in short-term (production) lending in the early stages to avoid any risk of default. Development lending may be undertaken selectively, at a later stage; and

(v) quality of lending, together with staff and beneficiaries' training, should never become secondary to quantity of lending in terms of volume of disbursement. Selective appraisal, high motivation of staff and close loan supervision are necessary for any early-stage lending programme to be (at least potentially) successful.